Last week as silver headed toward the $29/oz level, I received an excellent piece of commentary from a retired Canadian geologist that goes by the handle “Rhody.” In it he states that at sub $30/oz silver is below cost, which I take to mean marginal cost. For those not familiar with the commodity markets, marginal cost is the price that must be maintained to support new projects in order to keep supply growing to meet demand. This cost includes capital investment in addition to all other costs as well as an implied return on investment. I am not sure if Rhody included a return on capital in his $29/oz figure so it could be even higher. In any event, he goes on to make some extraordinarily poignant statements on the overall macro backdrop in general. So much so that I asked him if I could post it and he agreed. Without any further ado…

Hi Guys:
Silver has now dropped below its total cost of production, which averages about $29. Back in 2007, producers could produce silver at about $22 (which was above the spot price of the time as well) but at a 10% inflation rate, cost per ounce now, about 4 years later is going to be around $30. Ignore mining companies that say they can produce silver at 5 or $6. That’s just mining costs and ignores exploration, smelting, refining and shipping. Back in 2007, if you looked at the top three miners, looked at their production and profits, you could calculate their total cost at $20-$24 back while the spot price was $18. Essentially, silver has been produced below total costs since the 1930’s, which is why only 22% of silver mines subsist on silver alone and the other 78% survive on their other metal production with silver as a mere by-product. No straight silver mine makes money, unless it is very, very high grade.

So as of this morning, we are below cost in the spot market. This is back to normal for silver. Silver has re-joined the ranks of food, and forestry as industries which operate below total costs. 100,000 third world farmers committed suicide last year because of their horrible economic circumstances. Meanwhile there were food riots in middle eastern cities of North Africa, and Syria because of the “high” food prices. Does anyone else perceive the logical disconnect here? The problem of course is fiat money, and pricing commodities with derivatives that steal from everyone.

To get back to the thread below, gold and the dollar have risen together until 6 months ago when gold was crushed in the derivative markets but the Dollar held up. The firm Dollar is because Europe is under attack and with it it’s banks and currency. So Europeans pull their money out of their banks and buy either Dollars or gold as a flight to quality. The Establishment doesn’t like the gold buying so a very effective campaign of disinformation, derivative based suppression, and selling by Western central banks has sent the gold market down by 15% over the past 6 months. This cheapened metal has gone east, never to return.

Meanwhile the miners have been devastated and the Dollar has firmed. This is the intent. The World monetary system can be viewed as a huge tent, with a central pole (the U.S. Dollar), surrounded by secondary poles and tie downs. The central pole has become unstable, and as it does, it is the secondary poles and the tie downs that rip out of the ground and fail first, eventually leading to the collapse of the central pole. As the surrounding poles and tie downs (other fiat currencies) fail, their citizens flee to the remaining currencies that still survive, particularly the dollar, and its value rises because of the increased demand. Some, but not a lot of this liquidity flows to gold and other tangibles causing price inflation. So, in the end, gold and the Dollar will appear to rise together. Well, gold has stopped rising, so we are not at the ‘end’ yet. When we do reach the end, I expect a hyperinflationary event, which will drive gold in Dollars to levels which don’t bare mentioning, because in the end, no amount of dollars will buy an ounce of gold. The precious metals have been purposely knocked down here. People forget that although the metals are being slammed in the derivative markets, the decline has only been 15%, which is a moderate correction as these things go….. This could be your last chance to buy politically cheapened ounces. Don’t get upset, buy some more….

The dollar is terminal, for reasons that would take too long to describe. Let us just say that a credit-based fiat currency is eventually destroyed by the build up of debt that it produces. The Dollar’s debt burden has now become so huge that the entire world cannot support the interest payments to keep it viable, even at interest rates barely above zero. So, you have two choices: hold dollars as a storehouse of value for your savings, or gold/silver. There are other things you could convert your savings into, but they are far more cumbersome than Dollars and precious metals, so pick one or the other. One is about to disappear, so choose wisely.

Rhody

P.S. Yesterday, the 10 year U.S. Treasury dropped to 1.83% and even the CAD went below 2%. Would you lend a government money for 10 years at interest rates only one third the real inflation rate???! What is going on here is a manufactured perception that we are in a deflation. This will be the excuse that the central banks use to impose another round of Quantitative Easing, probably this summer. QE bails out the banks at the expense of stealing your savings via inflation.

9 Comments

First Majestic, the largest pure silver miner in the world, just reported their results today. In them was a complete confirmation of what Rhody referred to for marginal cost of production. From First Magistic today:” Total Production Cost per Tonne was $29.24, a decrease of 3% from Q1
2011.” So taking the largest silver miner in the world total production costs of $29.24 does indeed confirm this. No wonder silver supply has been consistently shrinking for decades and decades.

Correct about the tonne comment (although costs cannot possibly be $29 a tonne either) but cash costs are not marginal costs and THAT was the point about the article. You don’t invest hundreds of millions on new projects based on cash costs you do it based on marginal cost.

Couldn’t agree more and very helpful to read more details about where metals are relative to the marginal costs of production. QE3 is a lot more justifiable when gold has dropped and oil is below $90 a barrel.

Very interesting perspective which points directly to the level of collusion in the precious metals markets, particularly silver. I’m wondering if the largest purchaser of silver shorts, JP Morgan, may be forced to dump this strategy of suppressing silver prices now because of all the losses surfacing with their derivative mistakes. If it does, silver is positioned for some sharp rises because of its dual demand as a form of commodity money and its high industrial demands as well. Looks to me like silver at the current pricing is a really good buy.

I cannot believe this rubbish about silver prices and mining costs. Having spent nearly 30 years in the precious metals industry and visited most of the main mines in South America, Mexico, the African continent and elsewhere I am dumfounded by this continued insistance that Ag is undervalued. For decades Ag was traded for less than $10 an ounce and the mining companies happily continued mining at a profit. To confuse figures per tonne with figures per ounces is laughable (over 30,000 to 1} and then to try to explain it away by reference to “marginal costs” shows an abysmal lack of knowledge of the industry and the markets.

First of all, it was a random commenter that stated the tonne figure, not me or Rhody. He obviously had a typo, because as you state it is 30,000 oz per tonne. Second, I’m curious. Since you are such an expert on everything what do you calculate the marginal cost of silver to be and how do you come to this calculation? With a return on capital included and based on 2011 costs and the recent inflation rate.

Michael, I am not an “expert on everything”, just a very pragmatic investor who simply rejects the “doomsday” predictions where only holders of physical gold/silver will survive. I do hold physical stock of Ag and although hopeful of an upturn in prices, I am not at all confident in the short to medium term.
With regard to “marginal” costs for silver mining, there is no such figure which can be meaningfully applied universally as each mine has it’s own costs based on the type of mining, anticipated reserves, local labour costs, the expected life of the mine, cost of borrowing, etc. A majority of Ag mines have been producing for decades with extensions developed as and when economic conditions are favourable. Opening a new mine is a totally diferent proposition as you no doubt are fully aware.

Ive read your article and im now confused. I own a modest store of silver, and believe that I am purchasing at just about the cost of mining , refining, and shipping. Ive been buying ever since the price dropped below $23 / tr oz early last year. Now jan19 2014 and silver is just above $20. We all know that au and ag will rise on, if nothing else, inflation.
Perhaps not this year, but surely in 2015. Silver will be on golds coattails.